Russel Metals (RUSMF) CEO John Reid on Q2 2019 Results - Earnings Call Transcript

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About: Russel Metals Inc. (RUSMF)
by: SA Transcripts
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Earning Call Audio

Russel Metals, Inc. (OTCPK:RUSMF) Q2 2019 Earnings Conference Call August 9, 2019 9:00 AM ET

Company Participants

Marion Britton – Executive Vice President and Chief Financial Officer

John Reid – President and Chief Executive Officer

Conference Call Participants

Devin Dodge – BMO

Frederic Bastien – Raymond James

Derek Spronck – RBC

Michael Tupholme – TD Securities

Operator

Good morning, ladies and gentlemen, and welcome to the 2019 Second Quarter Results Conference Call for Russel Metals. Today's call will be hosted by Ms. Marion Britton, Executive Vice President and Chief Financial Officer; and Mr. John Reid, President and Chief Executive Officer of Russel Metals, Inc. [Operator Instructions] I would now like to turn the meeting over to Ms. Marion Britton. Please go ahead, Ms. Britton. Thank you.

Marion Britton

Good morning everyone thanks for joining our call. I am going to begin by reading the cautionary statement that is on Page 3 of our information that we circulated last night. Certain statements made on this conference call constitute forward-looking statements or information within the meaning of applicable securities laws, including statements as to our future capital expenditures, our outlook, the availability of our future financing and our ability to pay dividends.

Forward-looking statements relate to future events or our future performance. All statements other than statements of historical fact are forward-looking statements. Forward-looking statements are necessarily based on estimates and assumptions that, while considered reasonable by us, inherently involve known and unknown risks, uncertainties and other factors that may cause actual results or events to differ materially from those anticipated in such forward-looking statements.

Our actual results could differ materially from those anticipated in our forward-looking statements, including as a result of the risk factors described below in our MD&A and in our Annual Information Form. While we believe that the expectations reflected in our forward looking statements are reasonable, no assurance can be given that these expectations are proved to be correct and our forward-looking statements included in this call should not be on duly relied upon.

These statements speak only as of the date of this call and except as required by law. We will not assume any obligation to update our forward looking statements.

Turning to Page 5 we will – I'll just summarize few of the highlights of second quarter. Second quarter earnings 2019 were CAD31 million and CAD0.50 of EPS. You can see there are great results we did had in Q2 2018, I want to remind everybody that Q219 was actually a good year, a good result. I'm going to speak a little bit to that and then we get to the five year summary.

The six months we've produced an EPS of CAD1.05. Free cash flow was strong at CAD102 million for the six months or CAD1.69 per share, also our return on equity at 15%. It's very good result. We declared our dividend of CAD0.38 per share yesterday.

Turning over to Page 6, few market comments, demand is lower and steel price has come down compared to 2018 and earlier in the year. Metal service centers average selling price was 2% higher than Q2 2018 also the tons were down 7% compared to Q2 2018. The year-to-date also was down 7%. So volumes are down, to this point in the year selling price is up, I'll speak to that in a minute where we think it's growing.

Rig counts down in the U.S. and Canada both year-over-year for the quarter and currently remains down. Energy product segment revenues decreased 7% compared to Q2 2018 mainly related to the fact that rig counts have been down. Tariffs between the U.S. and Canada were removed in May 20, 2019, so during the quarter we had our tariff that were put in place last year removed and it did have an impact on further pressure downward on steel prices.

Turning over to the next page, Page 7, if you look there at our basic earnings, you will see what we produced between 2015 and 2018 and then in the Q2 of this year and last year –I mean, sorry, six months of this year and last year. You'll note that our results, if you were to annualize them are second best to our 2018 results produced. So we're still having a good year, although in most cases all our measureables are down, because 2018 was a spectacular year.

Down below you'll see the working capital of metal and you'll also – we have the fixed assets and everything compared over here. Year-over-year net assets employees are down from year-end slightly. We'll get into a little more detail on that in a minute.

Turning forward to Page 10, this is where I am going to speak to the change in working capital. So accounts receivable did was positive cash flow from accounts receivable, mainly collections in our energy and our decline in revenues as selling price did come off. Also impacted that, so CAD55 million[ph] in the quarter, CAD31 million year-to-date, inventories was down provided cash of CAD17 million in the quarter, CAD32 million, CAD33 million year-to-date. Accounts payable in the quarter was CAD55 million, that mainly relates to the fact that we've been reducing our inventories and as we reduced our inventories, we don't have the payments as we start to restock because our inventories in specialty metals service centers are now at lower level, we will get the payable. If you look at the accounts payable, it's down CAD81 million, or I mean utilized CAD81 million year-to-date. Part of that is because we did pay bonuses in February that were accrued at year end.

So the non-cash working capital movement, it’s been CAD22 million year-to-date. Also, you'll note significant income taxes paid year-to-date, related to some of the amount we were able to pay this year related to 18 in Canada and then payment over 19 Texas.

Moving forward to Page 13. You'll note at the bottom, we have updated the information on the tariffs U.S., Canada and the Canadian safeguards, what has been happening, we did also give some information on the fact that the Canadian Department of Finance has looked at the stressful steel matters and there are, sorry, that was the U.S. International Trade Commission, sorry I confuse the two. And Canada was taken out of the preliminary determination and there will be a countervailing duties against China and Mexico. So that hopefully, that section recaps everything that happened starting in 2018 and then some of it has been in – unwound into 2019.

Turning over onto Page 14. If you see the decline in total revenues, I've spoken already to the selling price and tons of information there. Just wanted to bring your attention to the gross margins, so gross margins for metal service centers down slightly from Q1, we anticipate some continued pressure on gross margins in metal service centers in Q3, maybe slightly lower than Q2, caused by the fact that plate is still declining and we will start to buy some of our other inventory at lower price, but we still need to average that higher price through the system. So we'll see some drag on our gross margins in the Q3 and should start improving in Q4, subject to anything else changing.

Energy products had consistent margins related to the first quarter, and that is created by the good margins in our oil field stores and the mix between oil field and OCTG. Still distributors are also more consistent with Q1, similarly, still prices have come off there, but we continue to be able to sell our product at reasonable margins. The net results of operating profit to revenues is reported down below. Metal service centers should improve as we go forward we hope.

The next Page 15, chart that explains IFRS impact of the capitalization of leases, so the assets and liabilities put on the impact of moving some of the EBIT into interests by segment, it's broken out there.

Moving onto page 16. So just to speak to the selling price, so selling price, I have indicated earlier was up 2%, compared to second quarter 2018, if you were to go backwards, you would see that in Q3 selling price actually went up 6% over Q2, 2018 and Q3 2019 is when we're going to drop below where we had been. So just looking – thinking back or taking a view back as to what happened in 2018 versus 2019, tariffs came on in May, June, prices started to ramp up, so selling price increased significantly for the second half of 2018, actually Q3 and Q4 were similar selling price levels for us. And we've now started to drop below those levels and we expect that Q3 2019 will be approximately 5% lower than Q2 2019. And times probably are going to be similar range or maybe a little bit more down than what we have experienced for the first half of the year, which is 7% down.

Turning to Page 21. Just wanted to speak to the inventory levels, you'll note that our inventory levels at June 2019 are very close to our inventory levels at June 2018. The area that we would like to see some improvement is our energy products. We only have turns to 1.9, we had 2 last year, so yes, second quarter is always challenging with the lower revenues, we hope that more activity, especially in OCTG in the second half of the year will help to improve that to some of the levels that we saw at other quarters during 2018 and earlier 2019.

The metal service center turns and levels, we’re very happy with as we mentioned, we have been selling off our higher priced inventory, we will be starting to replace that, that will help our average price in gross margin in the look forward. Still, distributors have brought down their inventory levels as they get to what the new norm is in North America with tariffs.

Those are my comments, and I'm going to open it up to questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And your first question is from Devin Dodge of BMO. Please go ahead.

Devin Dodge

Thanks, and good morning.

Marion Britton

Good morning.

Devin Dodge

So, obviously lots of moving parts on the pricing side, there was some helpful commentary Marion, thank you. Just trying to get a sense for maybe for each product line, obviously, you said plate continues to soft and does that continued through early Q3? And maybe just – maybe from other cost – other pricing commodity for other products that you sell, including maybe some of the energy space.

John Reid

Yes. So Devin, we’ll just – we'll start with flat rolled coil, as you have so many products – obviously, downstream or by-product does that. And it looks like it bottomed out early July and it started to bounce back now, we saw the numbers get – U.S. numbers get around 480. We've come back into a currency adjusted situation following the 232, we're now U.S. currency adjusted for Canada, which sets back to normal. If you look at the metal margins spreads, it feels like the mill has actually over-corrected on core products. So when it got down around that 485, 500 number, there was probably an over-correction. And if you look at the metal margin spread and the spread to the world market, I think that's recovering naturally, now you're getting it back to a normal metal margin spread, although it being on the low end. And it seems to be at a sweet spot to keep up imported back. But again, I don't see a whole lot of upside potential for it, but it seems to be at a good landing spot.

Plate on the other hand still has some metal margin room to run, we did see an increase of CAD20 a ton on scrap this month, the potential for scrap to be flat up again next month and that will probably take the metal margin back to a reasonable level for plate, so it definitely out ran and held longer. So I think plate through July, early August is starting to come back in line may be CAD20 to CAD40 a ton more to go, but we're getting to the bottom there. So the recovery so far that we've from the steel mills amounting to CAD40 increase, we've not seen that take, hopefully they're establishing a flow.

As far as tubing, tubular products, structural tubing, those products are following similar to flat rolled OCTG and line pipe typically run about 90 days in arrears on pricing. So they're continuing to drift south predominantly because a lot of the import timing of the market coming in, purchase of flat roll been made in North America and converted. So again, we're – we think we'll see that probably fall throughout the third quarter.

Devin Dodge

Okay. That's really good color. Thank you for that. So how can you, or how do you – can you give us a sense how you're feeling about inventory levels? I think you addressed some of this maybe in the prepared comments. But just I guess in particular inventories were up at energy products. Just how should we be thinking about that given the context that OCTG pricing seems like, it's set to fall in Q3?

John Reid

Yes. To start with service centers, we're in really good position with service centers, our Canadian service centers will push over four this month, U.S. service centers will push over six turns this month. We are high on our energy terms for OCTG and line pipe in the quarter, that will be an emphasis for us in the third quarter, we need to do a better job there getting those in line. So we're pulling back on our purchases there dramatically and looking to move material, again it will be at under margin pressure though because of the pullback in price.

Devin Dodge

Okay. That's helpful. That's it for me. Thank you.

Operator

Thank you. Your next question is from Frederic Bastien from Raymond James. Please go ahead.

Frederic Bastien

Hi, good morning. Just want to follow-up on that last question. Do you have any concerns around the net realizable value of your inventory across segments?

John Reid

Service centers, I think we're in good shape Frederic, I think in the steel distribution, that we're in pretty good shape there, there may be a slight adjustment in the U.S. there, but it would be – not be material. On the energy side, it'll remain to be seen where we bought them out on that, it is potential for one, but I don't think we're looking at anything large materiality, nothing like we've done in the past.

Frederic Bastien

Okay, cool. I was pleasantly surprised with how pricing held up during the quarter and based on your comments around the second half Marion, it looks like ASPs would settle higher than they were before the imposition of tariffs. Is that a correct assumption?

Marion Britton

Yes, I think so.

Frederic Bastien

Any guesses to how much higher they could kind of sell that or is it too far out to tell?

Marion Britton

Too far out to tell at this point, I think we have to let the dust settle a bit more.

Frederic Bastien

Okay. But still a very good environment from a pricing perspective.

Marion Britton

Yes.

John Reid

Yes.

Frederic Bastien

Okay. And I guess John, I think we ask you that question every quarter, so I'll ask again. On the energy side, the rig counts are trending lower, but I guess at the same time in your comment, you're saying, you're seeing continued positive momentum in the Permian Basin. It looks like things are finally moving along with LNG Canada. So given this backdrop, how are you feeling about the outlook for energy products into the second half, and then into 2020?

John Reid

We feel like the Permian is obviously one of the hottest spots in North America right now, we're continuing to grow there and really putting an emphasis on future growth there. The LNG has taken off, we're getting some positive momentum, where we just landed a nice Samco project that we've been working on with Comco, that will go back through the end of the year, roughly CAD50 million project. So we're starting to see some positive things happen there in Canada. But again, I think most of the growth that we will see will be in the U.S. predominantly in the Permian.

Frederic Bastien

Okay. Well, the growth of LNG offsets some of the weakness you're using in Alberta mainly.

John Reid

Yes, we’re doing, I mean we’re doing reasonably well in Alberta with energy right now. So again, I think that'll offset itself, yes, it's just a matter of how much capital is going to be spent, continued to be spent in Canada, that's non-gas related to the little concern.

Frederic Bastien

Okay. Thanks. That's all I have.

Operator

Thank you. Your next question is from Derek Spronck of RBC. Please go ahead.

Derek Spronck

Good morning, thanks for taking my questions. Do you feel that you have enough visibility around steel pricing and market demand to maybe look at acquisitions again?

John Reid

Again, we're always looking at them Derek, with the cyclical nature of our business, especially in the downturn, we typically throw off cash, it's a matter of valuation that again with the cyclical nature, we really don't try to time the market, it's more of a – when the opportunities arrive and it fits for our organization.

Derek Spronck

Valuations, you have those conversations or do you feel more comfortable, maybe being a little bit more focused around that and perhaps valuations are little bit more attractive now. Is that a fair statement or?

John Reid

Yes. The volume has slowed of what we're seeing that's out there, the deal volume, that’s what we’re seeing. But as far as valuations, we typically look at a four to five year trend. And so, even in an up market that balances itself out as well. So we're looking at the cyclical nature again and trying to put a price tag on that, where we can get a stabilized return that's accretive for us, again accretive for our capital structure, not just our earnings.

Derek Spronck

How would you characterize your capital allocation priorities over the next 12 months?

John Reid

Of course inventory will be one, we'll be watching closely and we'll continue to push through that to see where the market is heading. So we’ll be looking at equipment in our value-added process, and then we have the – we'll be looking at our computer system, and then obviously our dividend, is always our top priority.

Derek Spronck

Okay. And do you expect to see a little bit of a reversal on working capital trends and perhaps a reduction in inventories over the next several quarters? Or…

Marion Britton

I think that is – yes, that inventory will come down and IAT will actually generate cash, conceivably the remainder of the year because we will need to start buying again in our metal service centers, I mean, one of the things that happens in the falling market is you wait as long as possible to replace your inventory as you then move out all your high cost inventory and also you figure out somewhat where the bottom is at some point you do have to buy. So we will increase their AP, so that will happen, positive impact on working capital.

Derek Spronck

Okay. And then, just one last one for myself before I turn it over, any color or update around U.S. metal production following the last call it eight months of the tariff and geopolitical dynamic?

John Reid

Yes, the challenging thing to follow up based on historical numbers are the new quotas that are in place with various countries. So, some of those were starting to fill up. So there will be some natural replacement in that so you can get a little bit of false rating there from time-to-time.

So you may have more metal capacity coming online in a time when you're actually not shipping as much. So we're trying to watch over all shipments and lead times closer. Again now with Mexico and obviously with Canada being out of that mix with the 232, that will create a shift just comparing to last year, so we do year year-over-year. So again, we watch lead times closer, really watch scrap closer. And then as the sustainability of pricing is the ultimate measure to see how strong demand is.

Derek Spronck

Okay. And you're seeing a bit of a pickup in the scrap pricing, right?

John Reid

Scrap pricing has come up CAD20. We think it could come up another CAD20 to CAD40 in Q3. So we're definitely seeing an upturn there, same with steel pricing with the exception of plate product as I mentioned before.

Derek Spronck

Okay. All right. Thanks John and Marion for the additional color.

John Reid

Thanks, Derek.

Operator

Thank you. Your next question is from Michael Tupholme from TD Securities. Please go ahead.

Michael Tupholme

Thanks, good Morning. John, just in terms of your comments around plate, having more room to run, you think we're at a bottom here and the next move is upward and falling or equal upward? Is that what you're suggesting?

John Reid

I think plate is probably getting close to a bottom, very close and probably going to hold. So I think we're getting to normal spreads. Our historical spreads you would see between plate and coil are probably over corrected, plate is yet to get there, the metal margin spreads were exceptional on plate for the last year. So I think plate is probably getting close to a holding point so we may bounce up or down CAD20 more, following scrap pricing. I think overall, I think it's at a holding point right now.

Michael Tupholme

Okay. And with the same hold true for hot rolled coil, and in recognizing, we've already seen the bounce, but you think, that’s sort of played out and we stay stable from here?

John Reid

That stable as the steel business has been, which hadn't been in my 28 years. But again, I think unless we have a big change in demand up or down or we have a wild swing, I think it will – I think it would typically follow scrap right then.

Michael Tupholme

Okay. In the outlook commentary, in the MD&A you talked about overall demand having softened slightly in all of the business segments. Can you just expand on that a little bit? I guess in service centers, for example, is this across the board or are there certain end markets that have seen greater softness. And just to be clear, is this sort of relative to Q2 is what you're indicating in terms of softening?

John Reid

That seems to open in Q2, we think it'll carry over into Q3. But again, if you look at Canada being a resource driven economy, if you look across the resources, oil, natural gas, mining, ag, so as we look into things that are out there, those have all softened across Canada. Construction has softened but it's opened its head, okay. If you look in the Greater Toronto area, it's very busy, but across the rest of the country moving into the eastern side of Canada though construction is pretty strong in Quebec and then shipbuilding for the government vessels in Atlantic, Kansas, very strong. So those are kind of what we're seeing across Canada.

And in the U.S. it's more across the board, there we've seen the softening. The demand, other than probably heavy equipment, which seems to be holding flat were slightly down, the rest seem to have dropped off maybe 3% or 4% more than we anticipated.

Michael Tupholme

Okay. And again, this is a further decline relative to Q2, the third quarter being a little bit softer than you saw in Q2, is that you mean?

John Reid

Yes. Right now, it's difficult to tell, but we would see the third been a little bit softer. But again, you're coming through summer holidays, you got the Quebec construction slow down. So there's a lot of variables that's little cloudy right now to get our head completely around what seasonality and what's actual slow down that it feels a little softer overall right there.

Michael Tupholme

Okay. I know it wasn't a big number, but the inventory impairment charge in the quarter, Marion, CAD2.2 million was that all in one particular segment or was that sprinkled across few segments?

Marion Britton

It was sprinkled across, the bigger one was energy, but there was a little bit in service center.

Michael Tupholme

Okay. And just back on your commentary, Marion about gross margins in service centers, you could see some further softness or deterioration in Q3 relative to Q2. But you think that at that point we sort of bottomed?

Marion Britton

Yes, that's what I think. The biggest thing is when you see the steel prices coming down, as I mentioned, we wait as long as possible to replace the inventory and so you're selling off that high price, which drives your margins down. As we start to replace our average will come down. And the replacements will start in Q3, but the average will become down even more in Q4 in my mind, which will help [indiscernible] to margin.

John Reid

Yes. We won't increase the bottom for sometime in Q3. So it'll take a lot of to reverse course.

Michael Tupholme

Right. And how do you think about a normal margin for that business? Once you've sort of worked through the higher cost inventory where does that sort of stabilize that once you finished getting through that?

Marion Britton

Well, I think we'll go back up into the low-20%, 21%,22%.

Michael Tupholme

Okay. So as we look at the next year and assuming anything that can happen with prices between now and next year, but that's how we should be thinking about sort of the margin as we look out to next year, assuming a relatively stable steel price environment?

Marion Britton

Yes, that's what I would say. Yes, we may not get back to the 21% in Q4 but we'll be heading up into the 20%.

Michael Tupholme

And is there anything going on with margins in energy products as we look out the next few quarters in terms of similar dynamic?

Marion Britton

Well, it really depends on what happens on pipe. And I think, there is a bit of the price movement, but I think the biggest thing will be, that rig count start to or activities start to happen, particularly OCTG in Western Canada. If it's slow, we will get competitive pressure on top of lower pricing, which could impact price more than you would hope.

John Reid

Energy services business, the Apex type businesses out there pretty stable on margins because it's such a highly engineered product. So we have very little movement there. So that margin is pretty stable. You'll see some pressure but not as much as you do in OCTG and line pipe and on our other product ranges.

Michael Tupholme

Okay. That's all for me. Thank you.

Operator

The next question is from [indiscernible] an Investor. Please go ahead.

Unidentified Analyst

Hi. I keep looking at the dividend here and looking at the pay-out, about 76% somewhere I see somewhere I see leads about CAD7 million bucks in free cash flow. I just don't understand how that can continue to pay out that much dividends and still make acquisitions.

Marion Britton

We're a working capital company, it goes up and down. But if we make an acquisition, we obviously will take on some more debt, but there would be a working capital type acquisition which would allow us to borrow more. We as a company, we throw off a lot of cash and we feel the best thing to do with it is to pay a dividend to our shareholders.

Unidentified Analyst

Are you guys afraid that if you cut that dividend, the stock will just be reduced big time?

Marion Britton

We are – well, we're not afraid of that. We have over a number of years become a dividend yield stock and we protect the dividends. Any acquisition we do has to be accretive to the dividend, not just accretive to CAD1 on the bottom line. If it's not going to return enough to continue to pay this level of dividends and we shouldn't be doing it.

Unidentified Analyst

Right, because I'm still looking at that long-term debt from where I see and your financials, like CAD440 million, still a lot considering this quarter after the dividend was paid CAD7 million bucks in the earnings.

Marion Britton

I'm comfortable with it. Our debt equity levels are very low and that is how we monitor. If we are eroding our equity too much, I would be concerned, but as a company we have very low-debt-to-equity levels.

Unidentified Analyst

Yes. I just look at the 18% margin with the 7% dividend out there and that's pretty skinny to me.

Marion Britton

We've watched this over a number of years, as if you were to go back, you would see, I think we set our 70th quarterly dividend, we've been paying dividend for a long time.

Unidentified Analyst

Yes, I got it. Okay. Thank you. Thanks.

Operator

Thank you, there are no further questions. You may proceed.

Marion Britton

Thanks everybody for joining. Enjoy the rest of the summer and we'll talk to you next quarter.

Operator

Ladies and Gentlemen, this concludes your conference call for today. We thank you for participating and we ask that you please disconnect your lines.